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The income taxation of trusts is governed by Subchapter J of the Internal Revenue Code, §§ 641 through 692. For purposes of certain provisions within Subchapter J, a trust will either be classified as a simple trust or a complex trust.
Simple Trust: A simple trust is (1) required to distribute its entire accounting income every year; (2) has no beneficiaries that are qualifying charitable organizations; and (3) makes no distributions of amounts allocated to the corpus of the trust.
Complex Trust: Is defined as any trust that is not a simple trust.
Trust Taxation: In general, the taxable income of a trust is taxed to the entity or to its beneficiaries to the extent that each has received the accounting income of the entity. In effect, Subchapter J creates a modified pass-through principle, so that whoever receives the accounting income of the entity, or some portion of it, is liable for the income tax that results.
Special Rules for Grantor Trusts
A Grantor type trust is a legal trust under applicable state law that is not recognized as a separate taxable entity for income tax purposes because the grantor has not relinquished complete control over the trust. Internal Revenue Code Sections 671-678 apply to grantor trusts. Certain conditions which would be viewed as keeping the grantor in control are:
If any of these controls are retained by the grantor the trust is ignored for tax purposes and all of the associated income and deductions of the trust are treated as belonging directly to the grantor.
Generally, most irrevocable Medicaid or asset protection trusts are simple grantor trusts during the life or lives of the grantor(s).
Filing Requirement of a Grantor Trust
The income and deductions applicable to this income must be reported by the grantor on his or her own federal income tax return.
New York State Filing Requirements of a Grantor Trust
The income would again be reported by the grantor on his or her own New York State personal income tax return.